Managing Cash Flows in Volatile Markets – Tools, Techniques … · 2017. 11. 2. · Cash Mgt and...

Managing Cash Flows in Volatile Markets – Tools, Techniques and

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Techniques and Global Experience

CFO Conclave24-26 November 2011

Agenda

Backdrop

Framework for Financial Risk Management

The Cash Flow at Risk Model

Q&A

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November 2011CFO Conclave

Backdrop

Key structural change in the last few years:

‘Financialisation of the real economy’

Dr. Y.V. Reddy

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Backdrop

• Today’s economy brings new challenges :

� Managing an international business in a competitive global and uncertain economic conditions; and

� Facing sharp volatility in currency, commodity and stock prices.

• These challenges are important to all businesses

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Backdrop

• What we aim to present are tools that help businesses:

• Understand the impact of volatility on their cash flows and earnings

• Embed this understanding into strategic and operational decision making

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making

• to enhance business performance; and

• create a competitive edge.

• Measure and control risk exposure; and

• Support the development and execution of business strategy for example like hedging.

Slide 5


The environment

Benign

• “Stand alone

systems /markets

get connected

• Global in balance

of current accounts

• Excess liquidity in

Emergence of crisis

• Sub-prime market

unfolds

• Banking crisis

(Lehman , AIG,

etc.)

Provisional stability

• Emergence on

alternative

investment models

• Currency

management / war

The Feedback Effect

• Losses filtering through

the system

• Western governments

over commitment

• Counterproductive

The Future

• A co-ordinated global

approach?

• Rebalancing between

producing and

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• Excess liquidity in

the global financial

markets

• Increased

commodity

consumption

• Continuous growth

in Western

Economies

achieved through

consumer spending

and borrowing

• Advent of on-line

communications

etc.)

• Market and

Investors

overreaction

• Heavy government

Intervention

• Integrated action by

global monetary

authorities

• Quantitative easing

management / war

• Government

support to private

sector loss

• Bi-polarization of

political and

economic

management

• Emerging markets

orientation

• Political Instability

• Counterproductive

and clashing monetary

and fiscal policy

• Re-entrenchment to

“local” solutions

• Volatile flows in

Emerging Markets

• Investors Overreaction

• More Quantitative

easing

producing and

consuming countries?

• Currency instability?

• Commodity price

instability?

• Inflation / deflation?

Heightened uncertainty

43

51

Aug-11 Sep-11 Oct-11 Nov-11

FX Rates

USD INR

Market volatility continues…

• Rupee depreciation posing a risk

• Metal prices looking down

• GDP growth expectations slashed

• Sharp contraction in investment

• Moderation in corporate margins

10000

USD per MT

Copper

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6600


USD per MT

2000

2700


USD per MT

Aluminium

6.5 6.3

8.7

7.3

9.4

8.8 8.9

8.4

7.8 7.7

0

2

4

6

8

10

12

3

4

5

6

7

8

9

10

Mar 09

Jun 09

Sep

09

Dec 09

Mar 10

Jun 10

Sep

10

Dec 10

Mar-11

Jun 11

Sep

-11

Quarterly Inflation

Change from a year earlier

GDP Quarterly Growth

Change from a year earlier

India's GDP moderates as Inflation continues to soar

The market scenario continues to unfold…

The Business fundamentals

• Any successful strategy revolves around achieving a combination of three basic fundamental goals:

Given the current global economic and political scenario, corporate risk management strategies can be summarised into the following options:

o “Do nothing”

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Business Fundamentals

Minimisation of Variances /

Volatilities of Cash Flows and Earnings

Cost Control

Income Growth

o “Do nothing”

o Planning and forecasting

o Transactional : operational hedging

o Active risk management

8

June 2011Making Decisions Simple

Financial Risk Management Framework

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Financial Risk Management Framework (1)

• Effective financial risk management enables management to:

� Develop an explicit risk appetite that informs business strategy

� Execute effective hedging strategies; and

� Maximise profits, within the scope of strategy, whilst minimising earnings volatility, maintaining sufficient liquidity and sustaining

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earnings volatility, maintaining sufficient liquidity and sustaining growth.

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Financial Risk Management Framework (2)

• Achieving this requires a fully integrated financial risk management framework, enabled by a cash flow at risk model (CFaR) and embedded in treasury, trading, banking and operations activities. Such a framework must explicitly take account of:

� The illiquidity, co-dependencies and complexity of financial risks;

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� The business’ key pressures and constraints (performance, capacity, competition); and

� Reconcile strategic objectives with the quantification and aggregation of the risk arising, including

� The decomposition of exposures into specific risk factors.

Slide 11


Financial Risk Management Framework DesignKey design principles

Strategy

Organisation and

governance structure

The design principles guide the definition, operation and implementation of the operating model

Treasury Objectives

Business Objectives (including financing strategy)

Treasury Design Principles

Policy frameworkGovernance arrangements

Monitoring

Global treasury

organisation

Approach

• Clear objectives, aligned with global business objectives.• Uniform global approach.• Policies cover all risks and businesses.• Full segregation of duties.• [Value added service centre treasury. No speculation.]

Risk Management

• Risk managed on aggregate basis. Global limits set then subdivided.

• Enterprise Wide At-Risk (EWaRM) Model supports formal expression of risk appetite.

• EWaRM supports active risk management.

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Risk management

Infrastructure

STANDARDS FOR THE

MANAGEMENT OF KEY RISKS

Policies

Accounting treatments

Key Processes

SUPPORTING GLOBAL TREASURY INFRASTRUCTURE

Roles and Responsibilities

TechnologyReporting / Forecasting

Cash Mgt and banking structures

Procurement Centres

Global/ Regional Payment Factories

Monitoring

framework

The key operating standards for treasury management in Tata Steel Group taking into account the “as is”, good practice, the business context and the outputs of the CFaR model

The key operating standards for treasury management take into account the “as is” situation, good practice, business context and outputs of the EWaRM model

Hedging• Natural hedging first then use vanilla derivatives. Hedge accounting for derivatives.

Systems• Minimal use of spreadsheets. Use of global Treasury Management System.

Cash• Maximise pooling of cash and up streaming of cash to holding companies.

Payments• Global / regional payment centres for commercial payments.

Procurement Centres

• Seek to use set up to centralise cash and FX / commodity risk.

Trading (FX,

commodities, etc)

• Overall risk managed through allocation of capital and reserves.

• Value at Risk and risk sensitivity measures and limits used for monitoring.

• Monitoring driven by P&L instead of BS / notionals / limits.

• Collateral management required.

CFO Conclave

Cash Flow at Risk Model

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Slide 13

Using CFaR within a Financial Risk Management Framework to support decision making

Supported by CFaRoutputs, Board sets Risk Appetite and Financial

Strategy

Updated CFaR model

• An integrated approach to financial risk management will reduce earnings volatility and increase the effectiveness of business strategy.

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CFaR Model decomposes financial risks and reconciles to strategic forecasts

Trading divisions and treasury use model outputs to support hedging decisions

CFaR Model measures the effectiveness of

financial risk management in executing strategy

Updated CFaR model reconciles current risk management practices

with latest market forecasts and operational

data


Slide 14

business strategy.

Impact on P&L

Cycle 1 Cycle 2

Unhed

ged

Market Exposure

Hed

ged

Exposure

New

position

Hed

ged

Exposure

Time

Forecast Earnings

Cash Flow at Risk Model

Model objectives

• Provide an integrated forecast of the main financial reports and to illustrate the possible market driven variations from the expected outcomes.

• Enable different macro-economic scenarios to be considered, what-if analysis to be performed and to furnish the risk management and strategy functions with more robust and accurate information with which to make decisions.

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robust and accurate information with which to make decisions.

• Quantify, aggregate and decompose the risks involved in the businesses, providing the risk management function with better tools to design, implement and verify hedging/risk mitigation strategies.

• Identify and forecast the impact of debt and debt servicing costs in the debt ratios, allowing management to analyse the potential impact of possible capital structure strategies.

• Allow for enhanced articulation of risk appetite, validation of equity analyst forecasts and quantification of the impact of potential acquisitions and divestitures.

Slide 15


CFaR: Applications

• Fine-tuning of the annual business plan.

• Monitoring long term cash flow requirements.

Financial Planning

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cash flow requirements.

• Debt financing analysis.

Slide 16


CFaR: Applications

• Fine-tuning of the annual business plan

• Monitoring long term cash flow requirements

Financial Planning

• Scenario planning.

• Risk appetite setting.

Business Steering

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cash flow requirements

• Debt financing analysis• Hedging strategy

oversight.

• Strategic planning review.

Slide 17


CFaR: Applications

• Fine-tuning of the annual business plan

• Monitoring long term cash flow requirements

Financial Planning

• Scenario planning

• Risk appetite setting

Business Steering

• Computing the annual business plan.

• Risk exposure

Treasury Management

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cash flow requirements

• Debt financing analysis• Hedging strategy

oversight

• Strategic planning review

• Risk exposure measurement at a granular level

• Risk exposure management at a granular level.

• Financial planning.

Slide 18


CFaR: Model Outputs

Model outputs

The outputs of the CFaR model include:

• Full horizon analysis.

•Monthly risk ranking.

•Monthly probability distributions.

• Aggregate probability distributions (3 month, 6 month, 1 year, 3 year and 5 year intervals).

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month, 1 year, 3 year and 5 year intervals).

• Covenant breach heat map.

• Risk decomposition analysis.

• Risk sensitivity analysis.

• Financial statements expectation reports.

•Hedge effectiveness analysis.

Slide 19


CFaR: Example OutputsAggregate probability distributionsMonthly risk ranking

Raw Materials Procurement

Rank

Month

Number

At Risk

(INR Billions)

1 Month 60 0.040

2 Month 14 0.030

3 Month 49 0.010

4 Month 11 0.030

5 Month 28 0.010

6 Month 7 0.008

7 Month 47 0.005

8 Month 40 0.003

9 Month 38 0.002

10 Month 42 0.001

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EBIT Risk Sensitivities

Movement -5% -1% 0% +1% +5%

Risk Factors

INR Billion

FX Rates

GBPINR 1.356 0.357 -0.2 -2.3

USDINR -1.1 -0.5 0.5 1.3

Interest RatesUSDLIBOR - - - - -

EURLIBOR - - - - -

CommoditiesMetal price -10 -3 0 1 3

Coal price - - - - -

Risk decomposition analysis Risk sensitivity analysis

Slide 20


Case Study 1 – Asian Shipping Company

PwC Slide 21


Asian Shipping Company

• The business issue:

� The company won a long-term transport contract with one of the largest Emerging Markets Oil Producers.

� Due to local regulation the contract, which was won through a tender process, required payments to be made exclusively in the

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tender process, required payments to be made exclusively in the local currency.

� Although the contract was fixed to the total volume of goods to be transported during a five year period, it did not determine a rigid time schedule.

� Market quotes from large IB’s to hedge exposures would render the contract not economically viable.

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• Exposure to three key risks:

� Non-convertible currency (no liquid hedge available).

� Oil prices (revenue, insurance and other costs linked to the commodity).

� Uncertainty around the timing of cash flows (lack of direct hedge).

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� Uncertainty around the timing of cash flows (lack of direct hedge).

• In short, generating:

� High volatility

� Significant tail risk

Slide 23



150000

200000

250000

300000

350000

400000Simulated Frequency A Comparison of Contractual Hedges

UnhedgedStructured Third Party HedgeTailored Hedge

PwC Slide 24


-50000

0

50000

100000

-100,000,000 -50,000,000 0 50,000,000 100,000,000 150,000,000 200,000,000

Potential Cash Flow (USD)

Tailoring of downside risk


• The application of CFaR allowed for an optimal solution to be built through a combination of mostly vanilla financial instruments:

� A series of borrowings and deposit schedules in the non-convertible currencies was agreed with a “regional” bank for dynamic management of the tail risk.

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� A combination of forwards, futures and swaps were placed through a number of financial institutions

� Limited use of exotics: structured barrier options for risk appetite management

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Case Study 2 – Car Leasing Company

PwC Slide 26


Car Leasing Company

• The Business Issue:

� Very competitive car leasing market resulting in limited margins to absorb volatility.

� Balloon structures (i.e. large end of term payout) popular from a commercial perspective.

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commercial perspective.

� Car Residual Value is the main source of volatility.

� Financial Planning forecasts explain deviations “after event”.

� Pricing carried out on a Finance Costs plus Markup Basis

Slide 27


Car Leasing Company

• The Implementation of CFaR allowed:

� The breakdown by risk factor and the allocation of these risk factors at a granular level to types of contracts, manufacturer and vehicle, led to transparency of the required underwriting price

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vehicle, led to transparency of the required underwriting price

� Artificial internal allocations of “profits” to centres were replaced by a clear understanding of profitability by leasing activity

� Treasury finance and risk management techniques were tailor made to suit each of the contracts underpinning certain manufacturers and vehicles.

Slide 28


Car Leasing Company

• Practical consequences:

� Sharper focus on manufactures and vehicles to provide the best profit - volatility combination.

� Active management of the combination:

� Implementation of 2 cycle scheme for high preserving residual

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� Implementation of 2 cycle scheme for high preserving residual value vehicles feeding back into better commercial discounts from manufacturers

� Residual value risk management through use of CDS for selected manufacturers

� Optimisation of the finance funding structure and channelling of flows through the most desirable contracts

Slide 29


Car Leasing Company

• From a business perspective:

� The articulation of the company strategy was clearly rationalised and communicated to all departments ensuring focus on the business objectives.

� Financial Planning became reliable, resulting in significant

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� Financial Planning became reliable, resulting in significant improvement on the management of external stakeholders

� Volatility significantly reduced and results steadily improved.

Slide 30


Thank you!

This publication has been prepared for general guidance on matters of interest only, and does

not constitute professional advice. You should not act upon the information contained in this

publication without obtaining specific professional advice. No representation or warranty

(express or implied) is given as to the accuracy or completeness of the information contained

in this publication, and, to the extent permitted by law, PricewaterhouseCoopers Private Ltd, its

members, employees and agents do not accept or assume any liability, responsibility or duty of

care for any consequences of you or anyone else acting, or refraining to act, in reliance on the

information contained in this publication or for any decision based on it.

© 2011 PricewaterhouseCoopers Private Ltd. All rights reserved. “PwC”, a registered

trademark, refers to PricewaterhouseCoopers Private Limited (a limited company in India) or,

as the context requires, other member firms of PwC International Limited, each of which is a

separate and independent legal entity.

Managing Cash Flows in Volatile Markets – Tools, Techniques … · 2017. 11. 2. · Cash Mgt and...

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